Fixed income markets have re-entered a period of heightened volatility in early 2025, as shifting macroeconomic conditions, evolving fiscal policies, and renewed geopolitical uncertainty have led to heightened recessionary fears in the U.S and meaningful movement in credit spreads. However, the high yield market recovered quickly and retraced most of the spread widening in a short span, highlighting the resiliency of the asset class. Below are several reasons why we continue to be constructive on high yield credit, and why we believe that the sector is poised to endure further macroeconomic uncertainty.

Credit Quality of the High Yield Market Has Improved

The credit quality of the high yield index has greatly improved over the past two decades, with a majority of the index shifting to higher-rated securities. Today over 50% of the high yield index is rated BB, while the proportion of the index in B- and CCC-rated securities has declined, as noted in Figure 1. This is important when thinking about potential industry default rates in a slowing economy, since defaults typically come from issues in the CCC bucket. With the index allocation to CCC near the lowest levels in 20 years, one may expect that default rates will not reach levels as seen in previous crises.

Financial Metrics Suggest Strong Issuer Fundamentals

High yield issuers have maintained strong balance sheets, making them well prepared to withstand an economic slowdown. Leverage and coverage ratios, two metrics that are pivotal when assessing the financial strength of high yield companies, continue to be in favorable spots, as noted in Figure 2. Specifically, leverage continues to be lower than pre-pandemic levels, indicating a more manageable debt load for high yield issuers. Interest rate coverage, despite some migration lower, still remains at a solid level after coming from a much stronger starting point. In addition to the improved ratings mix for the index, these strong credit metrics are supportive of high yield spreads remaining below long-term average levels.

Building off of this base, earnings for high yield companies have continued to be resilient during this volatile stretch. According to J.P. Morgan, almost twice as many companies have beaten expectations for EBITDA than have missed expectations during the first quarter of 2025. And while there have been some questions around future guidance with uncertainty in tariff policies, the number of companies issuing positive or negative guidance was slightly biased toward positive, again proving the resiliency of fundamental strength in the high yield sector.

Lower Duration Relative to History

One notable trend in the high yield index is that it has gotten much shorter in duration over time, falling from an average effective duration of approximately 4.5 years in 2006 to historic lows at roughly 3.0 years today. On the other hand, the duration for the investment-grade index increased over the same period to roughly 6.5 years. One reason is that this follows relatively slow periods of new bond issuance within high yield markets in 2022 and 2023, leading to a dramatic decline in average maturity for the index. A shorter maturity and duration profile typically reduces default risk over the bond's life, assuming other factors remain constant, as the window for issuers to face uncertainty is smaller. This phenomenon has helped contribute to tighter overall spreads in the high yield market.

Starting Yield and Lower Dollar Price Offer Attractive Entry Point

Starting yields for the index have remained elevated, offering higher levels of income to help boost returns. This is notable when looking at prior periods, as yields have typically been lower when spread levels have been this tight. As represented by the yield-to-worst (YTW) of the high yield index, starting yields have been much higher in the last three years, as noted in Figure 4, which was a direct reflection of the elevated interest-rate environment that began in 2022.

This is important because the higher starting yields offer a much better entry point. If we look back at the history of the index, when starting yields were above 7%, the index experienced strong cumulative forward returns of 8.8%, 16.8%, and 25.0% on a one-, two- and three-year basis, respectively. This historical performance underscores the benefits of investing in high yield when yields are at these levels.

And while spreads are below long-term averages, convexity in the high yield market has improved as prices have drifted below par value as a reflection of the higher yield environment. This has added to the potential for price appreciation to contribute toward total return, as well as offer a better cushion for investors buying below par bonds, which is generally rare when credit spreads have been at these tight levels. Additionally, issuers may elect to refinance upcoming debt before the listed maturity date, adding to potential total returns as the pull-to-par effect is realized over a shorter window.

Conclusion: Looking Ahead

Markets have shown modest signs of weakness in the first half of 2025, as notably softer economic data, worries of growth contraction, and policy uncertainty dragged on consumer sentiment. Despite these concerns, high yield returns have been positive, and we continue to believe that the sector can provide attractive relative returns for the remainder of the year. However, it is important to note that patience is key and being selective in adding risk is crucial, given the potential for idiosyncratic credit events to erode returns. Within our strategies, we remain selective in our positioning and continue to be vigilant about potential headwinds that could cause spreads to move wider, including signs of cracks in labor markets, tariff repercussions, and the U.S. Federal Reserve’s rate and fiscal policies.